Civil Fraud Quarterly Round-Up: Q1 2021
This article was first published by STEP in their Trust Quarterly Review: ‘Moments of truth’, Trust Quarterly Review (Vol18 Iss4), pp.36-41, 16 December 2020.
In this blog, I examine the impact of Sofer v Swiss Independent Trustees SA on practitioners in England and Wales, and explore the Court’s determination that an indemnity from beneficiaries in respect of claims does not automatically preclude a claim being made, and how trustees labelling a payment to beneficiaries of a trust a ‘loan’ does not necessarily mean that it is one.
Hyman Sofer was a successful businessman and investor who accumulated significant wealth in his lifetime. He died in 2016, aged 97. Sofer had two children with his first wife, Robert (the Claimant) and Tamara.
In 2006, Sofer set up a complex trust structure (replacing a pre-existing structure) comprising four trusts. Each of the trusts was named after a footballer who played for Barcelona football club: the Jordi Unit Trust, the Gabri Trust, the Puyol Trust and the Xavia Trust. The Jordi Unit Trust was essentially a holding vehicle for investments. The remaining trusts held units in the Jordi Unit Trust for the benefit of the intended beneficiaries. These trusts were entirely discretionary and no person had a fixed interest, but at the time the trusts were settled it was apparently intended that the Claimant (and his wife) benefit from the Puyol Trust, while the Gabri Trust and Xavi Trust were for the benefit of Tamara (and her husband and children). The England and Wales Court of Appeal (the Court) referred to these three trusts as the ‘beneficiary’ trusts. The Puyol Trust was the focus of the proceedings.
The trustee of all four trusts was Swiss Independent Trustees SA (the Defendant), a Swiss-incorporated and resident company carrying on business as a professional trustee. The trust was settled in Australia but governed by English and Welsh law.
The Puyol Trust deed provided that the Defendant may:
‘lend any money forming the whole or any part of the assets of this Trust to any person who may for the time being be a Beneficiary upon such terms as to repayment and interest or interest free as the Trustees may in their absolute discretion think fit’.
But also that:
‘The Trustees must not pay convey or transfer any part of the corpus of the Trust to any Beneficiary for any purpose prior to the date of death of Hyman Sofer.’
The trust document also contained the following exoneration clause:
The Trustees shall not be liable for or responsible for –
a) any loss or damage occasioned to this Trust or any assets of this Trust or to any person by the exercise or purported exercise of any power by this Deed or by law conferred on the Trustees or by any alleged failure to exercise any such power or
b) any other loss or damage to this Trust or any assets of this Trust howsoever arising except where the same shall be proved to have been caused by acts done or omissions made in personal conscious and fraudulent bad faith by the trustee charged to be so liable.’
Between 2006 and 2016, payments were made to Sofer from the beneficiary trusts purportedly as loans in accordance with the power detailed above to lend trust assets to beneficiaries (which Sofer was by then). No provision was made for security, interest or repayment. The loans due to the Puyol Trust amounted to approximately USD19.2 million. Of this sum, Sofer used approximately AUD9.5 million in 2012 to settle a tax dispute with the Australian Taxation Office. The Defendant had sought indemnities from each of the potential beneficiaries (which included the Claimant) in relation to the same, and a deed of indemnity had subsequently been executed in September 2012.
The Claimant issued a claim on 25 September 2018 against the Defendant. The Claimant alleged breach of trust and sought the following orders:
The Claimant submitted that the payments made to his father were invalid on the basis that they were gifts and in breach of the prohibition set out in the trust document. The Claimant also alleged that, from about 2012, Sofer suffered, and was known to suffer by the Defendant, from dementia.
In December 2018, the Defendant applied for an order that the claim be struck out, pursuant to rule 3.4(2) of the UK Civil Procedure Rules (the Rules) or, in the alternative, that the Defendant be granted summary judgment, pursuant to part 24 of the Rules. In May 2019, the Claimant made an application to amend his particulars of claim, pursuant to rule 17.1(2)(b) of the Rules, in an effort to further particularise the allegation of breach of trust and dishonesty. These were the two applications before His Honour Judge Paul Matthews in the England and Wales High Court (the High Court) at first instance in May 2019. At the time of the hearing, the Defendant had not yet filed a defence, but the documents before Matthews HHJ made clear that the allegations of breach of trust were denied and that (should there be any residual claim) the Defendant relied on the trustee liability exoneration case and deeds of indemnity.
Matthews HHJ, sitting as a judge in the High Court, found in favour of the Defendant and struck out the claim for breach of trust on the ground that it did not sufficiently plead a case of dishonesty to overcome a trustee exoneration clause.
It was common ground between the parties that fraudulent bad faith required a dishonest breach of trust to be established by the Claimant.
In reaching his decision, Matthews HHJ applied the test set out in Fattal v Walbrook Trustees (Jersey) Ltd for dishonest breach of trust, finding the pleading to be flawed because it failed to show either:
Moreover, the pleadings failed to identify the natural persons whose knowledge was to be attributed to the corporate defendant.
Matthews HHJ held that were the claim not to have been struck out, he would have given reverse summary judgment for the Defendant on the Claimant’s claim, in respect of all payments made to Sofer prior to the 2012 deed of indemnity. The Claimant had asserted that the indemnity did not amount to a waiver or consent to any breach of trust such that he did not know that what was described as a loan was in fact a gift and, consequently, did not understand the legal effect of what he was doing.
Matthews HHJ dismissed this argument, finding that it was:
‘not necessary that the claimant should have understood exactly what was the character of the payments, or whether or not the defendant was complying with its fiduciary duties in making them, only that they were being made by the trustees apparently under the terms of the trust, and that the claimant could not thereafter complain that these payments amount to breach of trust’.
The Court (Lord Justice Patten, Lord Justice David Richards and Lord Justice Arnold) unanimously agreed to reverse the decision at first instance.
Arnold LJ helpfully set out the relevant principles for pleading dishonesty (and statements of case, more generally) as follows:
‘23. More important for the purposes of this appeal are the principles governing the pleading of dishonesty. There was little dispute as to these before either the Judge or us. They were summarised, in my judgment accurately, by counsel for the Claimant as follows:
i) Fraud or dishonesty must be specifically alleged and sufficiently particularised, and will not be sufficiently particularised if the facts alleged are consistent with innocence: Three Rivers District Council v Governor and Company of the Bank of England (No.3)  2 AC.
ii) Dishonesty can be inferred from primary facts, provided that those primary facts are themselves pleaded. There must be some fact which tilts the balance and justifies an inference of dishonesty, and this fact must be pleaded: Three Rivers at  (Lord Millett).
iii) The claimant does not have to plead primary facts which are only consistent with dishonesty. The correct test is whether or not, on the basis of the primary facts pleaded, an inference of dishonesty is more likely than one of innocence or negligence: JSC Bank of Moscow v Kekhman  EWHC 3073 (Comm) at - (Flaux J, as he then was).
iv) Particulars of dishonesty must be read as a whole and in context: Walker v Stones  QB 902 at 944B (Sir Christopher Slade).
‘24. To these principles there should be added the following general points about particulars:
i) The purpose of giving particulars is to allow the defendant to know the case he has to meet: Three Rivers at -; McPhilemy v Times Newspapers Ltd  3 All ER 775 at 793B (Lord Woolf MR).
ii) When giving particulars, no more than a concise statement of the facts relied upon is required: McPhilemy at 793B.
iii) Unless there is some obvious purpose to be served by fighting over the precise terms of a pleading, contests over their terms are to be discouraged: McPhilemy at 793D.’
Although the Court commented that the amended particulars of claim were ‘not well drafted’, it noted that for present purposes it was:
‘not the felicity of the drafting, but whether as a matter of substance [the statement of case] pleads sufficient particulars to disclose a case of dishonesty’.
The Court went on to find that the particulars were sufficient to sustain a case of dishonest breach of trust and highlighted two key factors to be borne in mind when considering whether to plead a case of fraud:
Concerning summary judgment, the Claimant’s position was that the indemnity only applied to payments that were loans as opposed to gifts or, in the alternative, that there was an implied term that, if not applying to payments, was made dishonestly.
Matthews HHJ had determined that, as a matter of construction, it did not matter if the payments were actually loans, simply that the Defendant asserted that they were loans in the indemnity document. He said that to construe the indemnity otherwise would be ‘uncommercial’. Matthews HHJ said that having already held that no allegation of dishonesty had been made, he did not need to decide the alternative case as to an implied term.
The Court disagreed. Arnold LJ commented that he did not see how a different interpretation of the indemnity document could be viewed as ‘uncommercial’ and that the indemnity could be construed as only authorising loan payments and, by implication, as not authorising dishonest payments.
The High Court noted that the structure of the trustee exoneration clause contained in the Puyol Trust document was ‘unusual’ (observing, however, that the document was drafted by Australian lawyers and it may therefore be widely used in Australia); nonetheless, widely drawn trustee exoneration clauses that exclude liability for everything except the trustees’ dishonesty or bad faith are commonplace in modern trust instruments in England and Wales.
At first instance, Matthews HHJ was referred to the UK Supreme Court decision in Ivey v Genting, in the context of the limits of trustee exoneration clauses. Ivey was a case about a professional gambler who was alleged to have cheated by the defendant casino, where he had won approximately GBP7.8 million playing baccarat. The scope of the appeal to the Supreme Court was whether dishonesty was a necessary element of cheating for the purpose of s.42 of the UK Gambling Act 2005 and, in determining this question, the Supreme Court took the opportunity to consider the test for dishonesty in the context of both civil and criminal proceedings. The Supreme Court overturned the long-standing criminal test set out in the case of Re Ghosh, with a unanimous decision that the same test should be applied whether the question arose in a civil action or criminal prosecution.
The Ghosh test had two stages: first, whether the defendant’s behaviour would be considered dishonest by ordinary, reasonable and honest people and, if so, whether the defendant must have realised that ordinary honest people thought that way. In Ivey, the Supreme Court held that the test for dishonesty is to ascertain (subjectively) the actual state of the individual’s knowledge or belief as to the facts and then determine whether their conduct was dishonest by the (objective) standards of ordinary honest people.
However, for a professional trustee, the second limb of Fattal sees the subjective test of Ivey qualified by an objective standard such that a trustee does not have an honest belief that he is acting in the best interests of the beneficiaries if, though actually held, it is so unreasonable that no reasonable trustee could have thought what he did (or agreed to do) was for the benefit of the beneficiaries. In Sofer, the judgment at first instance records a submission by the Claimant that the fact the Supreme Court did not address the ‘judicious breach of trust’ argument that led to the second limb in Fattal meant that there was no second limb and that the trustee’s belief about the best interests of the beneficiaries is inherent in the concept of dishonesty. Matthews HHJ dismissed the submission, and the Supreme Court did not need to consider, but it seems that the resulting lower threshold test may be subject to further scrutiny in future cases.
The decision of the Court in Sofer gives rise to some helpful guidance for practitioners in this jurisdiction when advising trustees as to the extent of the protection afforded to them by such exoneration clauses, as well as beneficiaries looking to pursue a claim against a trustee in overcoming them and how to plead dishonesty.
First, it should go without saying that both trustees and beneficiaries should be alert to the existence of an exoneration clause in the applicable trust document and, if there is one, the scope of that clause.
Second, practitioners should be aware that there is a different test for demonstrating fraudulent bad faith in order to overcome an exoneration clause to that of fraud or common-law dishonesty, namely that set out in Fattal.
Third, the court will adopt a proportioned and collective approach when considering factual allegations of dishonesty, and provided the cumulative allegations are capable of supporting an inference of dishonesty, that is sufficient for a general pleading of knowledge and dishonesty against a corporate trustee until after disclosure. Indeed, the Court’s judgment in Sofer demonstrates a reluctance on the Court’s part not to prevent borderline cases of dishonesty from progressing until the claimant has been afforded the benefits of disclosure.
Fourth, although loans are often used by trustees as a tax-efficient way for beneficiaries to receive benefit from a trust, Sofer highlights the risks associated with advancing monies in this way and the purported loan later being viewed instead as a distribution. Ultimately, whether a payment constitutes a loan or a gift is primarily a question of fact as to the intentions of the parties.
Fifth, trustees need to be alert to the extent of any indemnities entered into with the beneficiaries of the trust. It is recommended that trustees err on the side of caution and always seek to obtain widely drawn indemnities, particularly where there is a possibility that steps taken by the trustees could later lead to an allegation of breach of trust.
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